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Allied responded by waging a public relations campaign against Einhorn, questioning his motives. The war between Einhorn and Allied became well known in legal and financial circles.

Allied also worked behind the scenes to urge the SEC to investigate whether Einhorn was engaging in illegal behavior to undermine the company's shares, according to the inspector general's report.

Without any specific evidence of wrongdoing, Allied met with SEC investigators in June 2002 to urge them to investigate Einhorn. Shortly thereafter, the SEC opened a probe, questioning Einhorn about his trading activities, subpoenaing documents, and seeking his telephone records and a list of clients.

Soon after investigators started looking at Einhorn, they concluded that he had done nothing wrong. Investigators finished their review by mid-2003, but they refused to tell Einhorn the case was closed.

The probe was supervised by an enforcement bureau chief named Mark Braswell; he soon left the agency and went to work a Washington law firm, where he landed Allied Capital as a client.

Braswell said Monday that he couldn't comment on the inspector general's report without reviewing it.

Reaching out

While Einhorn was the subject of an SEC investigation into his activities, he tried to persuade agency officials to look into Allied Capital's practices. Einhorn's spokesman declined to comment.

The inspector general confirmed what Einhorn later wrote in a book, that he wrote a dozen letters to the SEC with detailed information alleging that Allied overvalued its portfolio.

Two separate agency offices -- unaware of each other's activities -- opened probes into Allied Capital based on Einhorn's letters.

The inspector general wrote that the first probe, conducted by the Office of Compliance Inspections and Examinations (OCIE), was prolonged by delays and involved just two officials.

One OCIE official overseeing the review told the inspector general that he trusted an Allied officer contacted because that person formerly worked for the SEC and was "not going to be doing anything illegal."

However, OCIE ultimately referred concerns to the SEC's enforcement division, which could take legal action against Allied. That division had already been investigating on its own.

Two years later, investigators determined that "more than a dozen of Allied's investments had significant problems with the calculation of their value and that Allied had materially overstated its" finances, according to the inspector general's report.

Allied's lawyers, which included a former SEC enforcement director, set up a meeting with SEC enforcement staff.

A year later, the SEC was persuaded not to pursue fraud charges against Allied, according to the report. Allied instead faced a more modest charge that allowed the company to settle without paying any penalties.